Reduce, Defer, Eliminate – Part Two

In Part One we talked about the immutable law of taxation. By way of reminder:

 As you increase the amount of tax deferred, you also increase the amount of control you have to give up to do it.

Since we have already discussed the “low-hanging fruit” of reducing gain and rate, let’s get to the meat of the discussion, and talk deferral.


Deferring gain is another great trick for two major reasons. The first is that tax rates are tiered. The more years we can stretch a gain over (generally) the lower the overall tax rate we will pay on it. If I can split my gain up over a couple years and stay out of the 39.6% bracket, I am going to be in better shape. We also are taking advantage of the time value of money. I will gladly pay you Tuesday for a Hamburger today. But how?

 Stretching Out the Taxable Income

The most common way to stretch out a gain is through a method called an installment sale. If you sell something for $500k, and have $300k of gain, under normal situations you would receive $500k and pay tax on $300k. But if you sell it and you agree to take your payment in five equal installments of $100k each for five years (usually plus interest), then the gain of $300k will be recognized at $50k a year for the five years. $300k is enough to jump several tax brackets. $50k might not be. You also get five more years of deductions to take against the gain. Sounds awesome, right? And it is! Except that you run the risk of the buyer going bust and never paying you. See what I mean about limitations? If you want all the money now, you pay all the tax now. If you are willing to reduce your level of control (because all you have is a promissory note, not cash) you can save a bunch of tax! No right or wrong here, just a different situation.

What if you don’t need the money right now, want to do an installment sale, but don’t trust the buyer to pay you? That is where the other option, a Deferred Sales Trust, comes in. Basically it works the same as an installment sale, but instead of getting a promissory note from the buyer, you sell the assets/stock to a trust for the note (which has to be run by a neutral third party) who then sells them to the buyer. The trust basically holds the cash and pays out on its promissory note to you. That way you still can stretch it out, but you have more security because the note is backed by assets you can verify. A couple caveats on this though. First, for this to be an arm’s length transaction, the trust has to have a profit motive. Which means that if you charge 5% interest on the note the trustee is going to invest that cash and try to make more than 5%, generating a profit for itself. Which means it could lose the money. Secondly, this setup has only been approved by the IRS via Private Letter Ruling. What does that mean? It’s complicated, but basically the IRS could come right back and say “never mind, we don’t like this and don’t want you to do it anymore” and force you to pay the tax, plus penalty and interest at any time. It is legal now, but the IRS can make things retroactively illegal. That’s right. I have seen it happen. They basically say, “Well yeah, it was legal when you did it, but now it’s not so you broke the law when you did it. Sorry.” Again, risk and reward people!

Another great option, usually only available to attorneys and other people that do contingency work is a structured settlement. Basically if you work for a portion of a reward (like a lawyer suing someone on your behalf), instead of having them pay you 30% of the settlement directly (the typical fee) you can write into the settlement that they have to pay you a monthly payment for life (or for 20 years, or five years, or pay you in three years, whatever you want, really) instead. This is accomplished by their taking the 30% and buying an annuity to fund their obligation. This is very similar to an installment sale as you only recognize the income when you receive it. This is a pretty niche trick though, so I won’t spend much time on the ins and outs.

 Reverse That

The other option for deferring is what I call the reverse deferral. In this situation you do not defer the gain, you pay it all at once. But you defer the opportunity to take losses and deductions against it. Primarily you use the Net Operating Loss (NOL) rules to accomplish this. The NOL rules allow you to “carry back” losses in the current year up to two years. So, let’s imagine that you do an asset sale of your business in 2013 and get $1MM. You still own the corporation. We set up a defined benefit pension plan and defer $250k into the plan for 2013, which means you have income of $1MM minus expenses of $250k for taxable income of $750k. Ouch. But you pay your tax. In 2014, you defer another $250k into the pension plan. You have income of $0 minus expenses of $250k for a $250k loss. You carry that loss back to 2013 and file an amended return. You take the $750k profit minus the $250k loss and get a refund. Repeat this process for 2015. In the end, you moved $750k of the $1MM into a pension plan (which you can withdraw from at whatever rate you want, whenever you want, thereby stretching the tax out) and paid tax on only $250k now. This could work for all kinds of other expenses, by the way, not just a pension plan. If your company still operates it might still need to have a company car, a company phone, or might have meals and entertainment expenses. All these deductions add up to what you can carry back.

Another method of the reverse deferral is to use something like a Family Limited Partnership (FLP). With this setup you make a partnership and contribute the assets you plan to sell. Typically to stand up, this needs to be done years before the sale takes place. You gift shares of the partnership to family members (primarily kids). When the asset sells, that gain is split up amongst all their returns, thereby stretching the gain across lots of smaller tax brackets. This tool is primarily an estate tax tool and not an income tax tool, but it can be used to help offset income tax while you are accomplishing your estate tax goals. As a side note, like in the NOL example above, the FLP might have operating expenses that it can pay that would be used to offset future or past gains. This tool can work really well if you want to give money to your kids now. And you have to. You cannot run an FLP and then not distribute the assets to them. Remember what I said about having your cake and eating it, too? You can’t use your kid’s tax brackets without losing that money.

 Gone for Good

The only trick that comes close to having cake and eating it is the stepped-up basis on inherited property. This is a pretty good trick. Let’s go over some terms. Remember, you pay tax on gain. Your gain is your sales price (X) – minus your basis (Y). Your basis is, typically, what you paid for it. It can be increased if you put more money in and decreased if you take money out. But to keep the example simple, assume it is what you paid for it. So X – Y = your taxable gain (Z). Z is what you pay tax on.

Now let’s assume Mom and Dad bought a house. They bought it 30 years ago and lived in it their entire lives. They paid $50k for the thing and now, when they both pass away, it is worth $750k. If you live in Southern CA like I do, this is a pretty common story. If Mom and Dad sold the house, they would pay tax on $700k ($750k – $50k). With me? Ok, now assume instead of selling the house, Mom and Dad pass away and leave you the house. What is your basis in the house? It gets “stepped up” to the Fair Market Value on the date of Death. So, your basis is now $750k. You immediately sell the house. You sell it for $750k with $750k of basis. How much tax do you pay? That’s right! ZERO! Death is the only legal way to make income/gain disappear forever. This works for any inherited assets: real estate, closely held businesses, stocks, bonds, etc.

Of course, in keeping with our theme of everything having a downside, with this, the greatest way to eliminate tax ever, you have to die. So there’s that. But still, neat trick right?! When you combine this with the 1031 exchange rules for real estate it can be a really great combo. A 1031 exchange allows you to not pay tax on the gain of a sale of real estate, as long as you immediately reinvest the proceeds from the sale in another property. So, if you have decided that you will always have rental real estate as part of your portfolio you can not pay tax on any gains, keep rolling the money over into new properties as the market allows. Then, all the gain you make along the way will be 100% tax free because whoever inherits the property will get a stepped up basis. Of course the other downside is that all that gain becomes taxable if you ever need the cash out of the property.

That is all the basics you need to know about deferral. Hopefully you can find something useful to help you! In our third and final part of the series, we are going to discuss ways to completely eliminate taxes.


If these strategies are interesting, or you think you might need additional help, please go to the contact page. I would love to work with you!

Big shout out to Jason Rehmus and for all his help in making this readable. I would be unintelligible if he wasn’t around. 

Reduce, Defer, Eliminate – Taxes on a Large Sale

It seems like everyone has a cousin who knows a guy that used a “secret” loophole to avoid paying a bunch of tax. I always say the same thing when someone brings that up: “Oh really? Well, then, you should probably go hire that guy!”

I hate it when professionals try to pull the wool over the eyes of clients by making them think these things are super secret or complicated or a fancy loophole. I like simple; it’s kind of my thing. Oftentimes, the application or implementation of some of these ideas can be complex, but the theories behind them are very straightforward. Understanding the theories can help you discuss and decide intelligently. So, here is my Business is Simple guide to avoiding tax on business sales or other large asset sales.

The first part of this theory is to understand the underlying law or principle. That law is this:

 As you increase the amount of tax deferred, you also increase the amount of control you have to give up to do it.

That is the trade off. It cannot be avoided. The tax code is designed to prevent you from having your cake and eating it, too. It is true for every loophole and trick you have ever heard of. That being said, the methods you can use, in order of usefulness, are Reduce, Defer, and Eliminate.


There are two things you can reduce: Gain or Rate. Reducing the gain means, obviously, you reduce the amount you stand to earn from the sale. Reducing the rate means that you pay a lower tax rate. For example, if you have a capital gain instead of ordinary income you would pay a lower tax rate. Reduction is not something that you can do easily. Usually everything that would qualify as a reduction has already been taken into account. The type of sale is usually set ahead of time. That is why reduction is kind of the low hanging fruit. If you can find something that was forgotten, great! And since it has the lowest chance of changing anything, reduction strategies usually do not require very much loss of control.


Reducing Gain

Your gain is what you are paying tax on. It is what you are selling the thing for minus what you paid for it (basis). So, the first step is to see how we reduce the gain. We can reduce it by reducing the sale price. Probably not a good tactic. Which means you have to increase your basis. Did you put money into the business or into the property at some point? Did you have losses on the business or property in the past you didn’t deduct? These increase your basis. Did you inherit the property or business? Did the property get a step up when you did? A “step up in basis” is what happens when you inherit something. Your basis becomes the fair market value on the date of death. None of these things apply? Next item.


Reducing Rate

This applies mostly to business sales. Businesses have two types of sales, asset and stock. In an asset sale a business sells the assets of the business (you would still own the entity you had beforehand, but as an empty shell). In a stock sale, you sell the shares of the corporation that owns the business assets. Why do we care? If you sell the assets, most of the gain you have will be ordinary income with tax rates up to 39.6%. If you sell the shares you have a capital gain where tax rates are only around 20%. That is a great trick. But most buyers of businesses want to buy assets, not shares. So, negotiate. If you do have an asset sale, you get to allocate the purchase price amongst the assets you are selling. So, you want to sell the hard assets (machinery, autos, equipment) for as high as you can (these are capital gain) and you want the non-compete or goodwill (ordinary income rates) to be as low as possible. Don’t screw the deal over this, but understand this can have a huge impact.

That concludes Part One of the guide. Look for Part Two where we discuss strategies to Defer taxes.


If these strategies are interesting, or you think you might need additional help, please go to the contact page. I would love to work with you!

Big shout out to Jason Rehmus and for all his help in making this readable. I would be unintelligible if he wasn’t around. 

“Pick Two”

There is a great diagram out there. I have seen it in the context of designers, saying that clients can have their project with two of three characteristics: fast, cheap, or good.

I feel there is definitely some of this in the business world as well, but that those descriptors aren’t quite right. So, I thought it would be fun to make an Accountant’s Venn Diagram.


You can have it Cheap.
You don’t pay much. You want to pay over time (or next week). You want to discuss all the forms, time sheets, and steps involved to determine exactly how a fee was generated. You want to discuss or negotiate every bill that you get. The check is “in the mail.” You assume that staff is free and office space is donated.

You can be Absent.
You are disorganized. You have a business but have no idea what an income statement is. Forget about knowing what assets and liabilities are. You use a shoebox for anything other than storing shoes. Your record keeping is that you have “almost all” of your receipts in this box. You don’t want to (or can’t) answer questions or organize anything. You can’t return a phone call or an email in less than four days.

You can be Informed.
You have very specific ideas about how your books/tax returns/project should look. You want to understand every single option, method, and choice and the pros and cons of each. You want concrete answers to amorphous ideas. You ask for the FASB or Revenue Ruling citation. You want all the details on a strategy, and weekly updates, forever.
Having all three of these things is impossible. But you can have any two of them. Each pair creates a very different type of relationship between you and I. Let’s look at how those look, so you can know what you want or need.

Cheap & Absent
Drop your stuff off, let me at it. I promise I’ll handle it. But you’re putting yourself in my hands and you need to trust me. This is really easy and requires almost no work on your part, but you better have trust in your CPA.

Informed & Cheap
This is a teaching relationship. You will have to keep bringing things up, but I will re-explain alternative minimum tax every year for you. Most of the relationship management (and oftentimes the work) falls on you. Most of the knowledge and teaching falls on me. I coach you, but I don’t do the work for you. Great for the DIYers, but be prepared for longer lead times and to crunch some numbers yourself.

Absent & Informed
I’ll be honest. This relationship is a TON of work for me to manage. Constantly chasing you down to give you the details you asked for can be exasperating. I don’t mind doing it. I really don’t! But if you want to demand that much knowledge from me and that little work on your part, be prepared to pay. This is the classic “for $400 an hour, I’ll do whatever work you want”.
As much as this may sound like a complaint, it isn’t. There is a place for all these types of clients and relationships in a business. As long as you and I understand the parameters, we will get along great! But if you expect to have the “trifecta” I can promise you will be disappointed.







Turning Pro – Review

I have read two of Stephen Pressfield’s books now and I have really enjoyed both of them. “Turning Pro” is a fantastic book, full of short and to the point chapters. Not even chapters, really. More like ideas. I found it even more compelling that “Do the Work”.

The central idea is that there are two types of people: amateurs and pros. The difference between the two isn’t what you might think it is.

Amateurs don’t pursue the things they want. They say they will, as soon as they can get free from their distractions. They then proceed to create as many distractions as possible. They live in a tortured mindset of always wanting something and not being able to get themselves to get there. Bhuddists might say that they are unenlightened, or spend most of their time not on “the Path”. We all know these people. In fact, we all were/are one. In short, they are phoning it in.

Professionals know what they want, know what it takes to get what they want, and suit up, show up and do the work. This does not mean that they are always happy, or pursuing their passion, or can make things happen that are impossible, or “think and grow rich.

I really struggle to explain the difference between the amateur and the professional. Pressfield wrote in such an emotionally vivid way, that it seems as if he never really explains the difference. He just tells stories, mostly about himself, until you grok the idea. I can’t figure out how to explain that. It really is an experience you have to just have.

Professionals don’t have all the answers and are not necessarily living a dream. But they find a sort of “zen” center in knowing they are pursuing something they enjoy and are good at, and they take comfort in knowing they are making progress towards something.

It is tough to describe in just a few short sentences, but the best example from the book is the Marine and his two salaries. His financial salary might be low, but he also has a psychological salary. The comfort and feeling of knowing that he belongs to something, that his calling has honor, and that no one can take that away.

If you feel like you aren’t living up to your potential, or that you could do even more, I encourage you to check out this book. It will definitely be worth your time.



The Way of the Shepherd – Review

I read “The Way of the Shepherdimages” at the urging of the owner of my company and discovered leading and managing are two very different things. If you are trained as a manager, and that is your comfort zone, then leading is going to be a significant challenge. This book, written as a fun parable, really helped me change the lens through which I look at the role of a leader versus that of a manager. It can be a difficult shift to make. What I have discovered is that leadership is equally easier and harder than managing.

Managing is about command and control. It’s about organizing a slew of projects and priorities and the vast swath of actions and tasks that need to be done to accomplish those projects. It’s about making sure that when A is relying on B and B is relying on C and C falls down, there is a way to keep the machine going. It can be an arduous task.

When trying to lead, it is easy to just expand the scope of the management operations. Management involves tracking tasks and projects. But trying to control the activities of everyone in a decent sized organization is impossible. Trying to manage the activities of professional staff is even more impossible. People are, well, people. They are not machines. They are unpredictable; sometimes they accomplish more than you expect and other times they fall far short of expectations. If you have a project sheet and task list for that person, you will pull your hair out trying to keep up. Their progress is their own, all you can do is try to guide it and protect them.

What I have learned is that leadership is just an entirely different way of doing things. Almost none of the tools that you use as a manager are useful in the leadership role. This book did a great job of laying out some simple ideas to get you started on the path to leadership. It certainly doesn’t have all the answers. It won’t cover every situation that might arise. But for someone like me who has seen the world through the manager lens for so long, it was the perfect short, sweet, and simple shake up that I needed to look at things totally differently.

The book really will take two hours to read. If you have people who report to you at ALL, you need to take a look at this book.


I have a couple random thoughts that I have been thinking about. None of them are large enough to be an entire post, so I thought I would do a “what I learned” post.

Thinking is hard work. You don’t realize it, but it is. And when the questions get bigger, it becomes even more work. But it is a very “hard to manage” work. If you had lots of tasks to accomplish, you could make a list, buckle down, and crank things out. But really big decisions permeate everything you do. Your brain doesn’t stop processing them because you’ve left the office. It doesn’t start processing because you have set aside a few hours to brainstorm. The thinking happens when it can, and there really isn’t much you can do about it.

Speaking of thinking, I heard an interesting idea the other day. My buddy, Matt—who has forgotten more about the markets and trading then I will ever likely know—and I were talking about the Fed, Treasury debt, and quantitative easing. We arrived at several conclusions. First, the financial markets are rigged against the little guys. It is sad, but true. It becomes critically important, if you are not a wealthy investor or institution, to look at how you hedge your risks.

The second thing we talked about what his idea to solve the debt crisis. It goes something like this:

The Fed is printing money to buy US Treasury debt. The Fed currently owns a significant chunk of the US government debt and is buying more each month. What would happen if the Treasury defaulted on just the debt that the Fed owned? You would instantly solve both the problems that worry most people: that the Fed’s balance sheet is getting too big and that the US government has too much debt. But with the stroke of a pen you could wipe out both of those things. Or if not wipe out, put a large dent into.

It makes you think about the money supply and how esoteric the whole thing is. Look for more on this idea later.




I Learned QuickBooks might not suck!

If you know me, you know that I dislike QuickBooks. For a variety of reasons.

What I learned this week is that I might be wrong. I’ve always known that I can be wrong, I’m wrong all the time. But I might be wrong about QuickBooks.

The new version of their online accounting software has been completely redesigned and the “test drive” I took was very cool.

It seems to me that QuickBooks just shifted their business to being an “eco-system” rather than a piece of software you use. This is a brilliant move on their part and all those other online software programs that I used to recommend should be scared, very scared. A couple high points, just from the few minutes I spent playing around with it:

-Mobile devices usage is awesome. It lets you fill spare moments with doing a little accounting work, instead of being idle. All those little moments add up to not much focused accounting work needing to be done, is my guess. A brilliant strategy and very reflective of the way people use their devices today.


-Linking up bank and credit card accounts in the background lets the computer gather the data for you to process. QuickBooks has had something like this for a while already, but it seems much more streamlined and easier to alter, making it is easier to start and stop that work, instead of having to find hours at a time to get accounting done.


-The “overdue” and “needs attention” warnings are awesome. By keeping small business owners (who by and large are accounting novices) focused on a couple issues, they can make meaningful impact on their business without knowing exactly how or why.


-Changing from a license billing model to a monthly fee model. This is the best part of the whole thing. Having the data in the cloud, with up to three simultaneous users (in the mid-tier version) eliminates the largest problem we have had with QuickBooks. They have really used all the best of currently available technology to really give the software a 21st century face lift.


All in all, I give this a solid thumbs up. I have talked a lot of Sh*t on Quickbooks and Intuit. This is me saying I was wrong, and BRAVO.

Look for more info on this later, as I start developing some guidebooks on how to run company on this software! I think this will be the backbone of how I tell business owners to run their business.


This week I learned about a clever evaluation tool called “DuPont Analysis“. It is a metric that measures Return on Equity by looking at three factors:



-Profitability (Measured by profit margin)

-Operations (Measured by asset turnover)

-Leverage (Measured by equity multiplier)

I thought I would share this because it was intriguing  how all the various ideas of business can be rolled in to one metric. Most small businesses won’t find this kind of analysis, in a technical sense, useful. Even if you have QuickBooks and have good records, sitting down to calculate this has little value.

However, it is worth noting, that no matter how small your business the idea still holds valid. Your business generates value in several ways:

Profit Margin: Is your core business model sound? Does it make sense? Am I generating sufficient profit on my revenue?

Operations: Am I using my assets (people, machines, inventory, etc) efficiently? A business with a sound model can still be run poorly from an operations stand point.

Leverage: Am I using my money wisely? In large companies this means “Do I have the proper capital structure for our business?”. But in small businesses it represents a much easier idea: “Am I using my money wisely?” Do I spend too much? Am I reinvesting in my business? Am I reinvesting in smart ways?


Anyways, just another example of my central thesis that: just because your business is small, doesn’t mean it can’t and shouldn’t be looked at in complete and sophisticated ways. And that can be surprisingly simple to do!

Current Account Balances are Simple!

I learned something important this week. Actually, I learned two things.

The first is that all those terms you hear on the news (and ignore) aren’t as complicated as you think. I don’t know where we got the idea that only experts and academics who do nothing but study can understand global trends in economics. Most people I know could follow a simple story about the first decade of the 20th century. I just wonder why no one explains it simply.

The second thing I learned relates to trade balances, current accounts, imports & exports and deflation. All those words that you usually ignore.

For most of the first decade of the 21st century, we have had low unemployment. Usually when unemployment is low for extended periods, inflation starts to become an issue. As employers have to pay more for labor (because there is a shortage) employees have higher pay. Employees with higher pay tend to increase their own spending, which bids up prices for goods, causing inflation.

But curiously, the inflation rate didn’t move that much in this time period. Sure, we had inflation, but it wasn’t out of control. Yet unemployment remained low. How did this happen?

The simple answer is the current account balance was negative the entire time. We “exported” our inflation. As developing countries, noticeably China and India, became more plugged into the global economy, we purchased more and more items more and more cheaply. This “deflation” offset the inflation that low unemployment was causing. The end result is that we landed somewhere in the middle of the two.

Trade isn’t a zero sum game! Those countries needed growth, we needed deflation, so they traded their deflation for our inflation and everyone ended up happy. Well, maybe not happy, but you get the idea.

Why should you care? Now that you understand the mechanisms, you can make sense of what people are telling you. You can now tell people who complain, “China is going to buy America because we owe them so much money!” that if they really understood trade balances, they’d know those countires needed our growth as much as we needed their savings.

You can also know that, if this trading starts to taper off (China’s growth starts to decrease, for example) there is a good chance our deflation will slow down. If deflation slows down, the opposite happens and we get inflation. With inflation, we get people back to work!

See? it isn’t that hard.

Selling a Business

This week I learned a lot of business are being sold right now. At least, there are in my world. This is not a comment on the business cycle as a whole, just an observation on what I see. It does make sense though, based on the demographics of the world. More and more Baby Boomers are looking to retire and trying to extract some value from their business is an important part of that puzzle.images (1)The real thing that I have learned, that is interesting, is that there is a LOT of variation in the market for buying and selling very small businesses. If you want to sell a company worth $50MM or more, there are lots of brokers, investment advisors, and consultants that can help. The market is pretty clean and professional. If you have a business doing $500k to a couple million a year, then it is quite likely that you are being under-served. Or worse yet, leaving money on the table.

The range of deals and brokers is vast. I have seen lots of brokers that are quite simply idiots (see my tweet about New Web Sights) and I have seen more that are just crooks.  I know, and use, some that are worth their weight in gold. But they are the exception, not the rule. I have had clients get such fantastic deals I almost feel bad for taking advantage of the seller. I have seen clients walk away from deals that were the best they were ever going to get, and accept deals that were way too low.

Here are a couple things I have learned from helping clients buy and sell businesses ( buying a few myself):1. Signing an exclusive contract with a big commission is not a mandatory part of the process.
2. Having someone who can take the emotion out of it for you is usually well worth the cost.
3. But don’t be afraid to shop that cost around!
4. Brokers will sell themselves by how much higher value they can get for you because of how they “market” your business. The truth is, their greatest asset is being able to connect you to possible buyers. You either have a great business or you don’t.
5. Get a realistic expectation of what your business is worth. Be prepared to support that value.
6. If you can’t produce numbers and support for how valuable your business is, then expect no value from the sale.
7. You might be pleasantly surprised by how much your business is worth. You might also be shocked at how much less it is worth than you think.
Even if you don’t think you want to sell your business any time soon, knowing what it is worth is critical. If you are planning to sell at any point, knowing this is even more important. So start gaining an understanding of how the process works ahead of time, and don’t get taken for a ride!